Amid the raging bull market, a big source of disappointment for investors has been persistent underperformance by actively-managed large cap equity mutual funds. Despite a modest rebound from their 2019 low point in terms of performance versus benchmarks, only 28% of these funds are beating their benchmarks this year, down from an average of 34% since 2009, Goldman Sachs reports.

As a result, actively-managed large cap mutual funds are beset by large net withdrawals of funds by investors. The aggregate year-to-date outflow through Oct. 31, 2019 was $229 billion, roughly in line with the average of $234 billion during the same period in the past four years, per Goldman's Mutual Fundamentals report released on Nov. 20. At the pace recorded through October, full year 2019 is on track to see net withdrawals of $275 billion, which would be the largest annual figure since 2016.

Key Takeaways

  • Large cap actively-managed mutual funds are seeing large withdrawals.
  • Most of these funds are lagging the market, more than in recent years.
  • On average, they have been underweight in the best performing stocks.
  • Lower outflows are likely in 2020, as policy uncertainty rises.

Significance for Investors

Goldman studied the portfolios of 617 funds with an aggregate $2.6 trillion in assets under management (AUM). Part of the performance problem is that the most overweight fund positions have lagged the most underweight positions by 125 basis points (bp), and the full S&P 500 Index by 150 bp, through October. Among the top 10 overweights are Google parent Alphabet Inc. (GOOGL), Visa Inc. (V), Adobe Inc. (ADBE), and MasterCard Inc. (MA). The 10 most underweight stocks include Apple Inc. (AAPL), Microsoft Corp. (MSFT), Amazon.com Inc. (AMZN), and Berkshire Hathaway Inc. Class B (BRK.B).

Looking at sectors rather than stocks, the average large cap mutual fund is underweight in information technology, the best performing sector in 2019. However, these funds also are overweight in the laggards, including health care and consumer discretionary.

"Funds raised their overweight exposure to cyclicals to the highest level since 2Q 2017," Goldman writes. They add: "Funds increased their relative allocation to Industrials (primarily Capital Goods) and Semiconductors. However, the current overweight to cyclicals still remains below [their 7-year] average." Nonetheless, "the cyclical bias of mutual fund sector exposures has supported fund outperformance in recent weeks."

Goldman also found that the funds most likely outperform were those with the most concentrated portfolios and the largest exposures to non-U.S. stocks. Regarding concentration, the report finds that funds holding fewer than 100 stocks are performing significantly better than those with more than 100. On international exposure, 33% of funds with at least 5% of their portfolios in non-U.S. stocks are beating the market in 2019, while only 28% of those with no overseas equities are doing so.

Meanwhile, although the percentage of large cap actively-managed mutual funds that are beating their benchmarks has slipped to 28% in 2019 from a 10-year average of 34%, absolute returns are up sharply compared to the last 5 years. Through October, the median fund in this universe produced a YTD return of 25%, versus an average of only 7% from 2014 through 2018.

Looking Ahead

"We expect lower outflows from active funds next year than each of the past four years because trade tensions and the 2020 US Presidential election will likely keep uncertainty elevated. History suggests that investor outflows from mutual funds are smallest following periods of high policy uncertainty," Goldman indicates.